Bill Discounting vs. Invoice Factoring – Trade Finance Guide 2019
In brief, Bill discounting and Invoice factoring are types of financial instruments that are used to provide capital to SME’s from invoices raised. It is an essential tool in today’s trading world which allows SME’s access to markets all over the world that would not have necessarily otherwise been attainable.
Bill discounting, or invoice discounting is the act of sourcing working capital from future payables. Furthermore, the seller recovers an amount of sales from the financial intermediaries before the due date.
Bill discounting can be defined as the advance selling of a bill to an intermediary (an invoice discounting business) before it is due to be paid. This results in less administrative charges, fees and interest. The interest and fee are calculated based on the risk of non-payment from the buyer, and so a funder will look at the creditworthiness and trading history of the customer rather than the business it is funding for payment.
In this arrangement, the initial owner of the invoices that are sold on is still in control of its own sales ledger and will chase payment in the usual way.
Invoice factoring involves a third party which is placed between the buyer and the supplier. The third party – who is the factor in this scenario – purchases a company’s accounts receivables (unpaid invoices) at a discounted rate. This gives the company in question access to a pool of funds that were tied up in the future. It also gives the third party higher value debt which will eventually pay.
There is, of course, Reverse Invoice Factoring, in which the third party commits to paying the company’s invoices at an earlier date in exchange for a discount. They then take their fees out and pass it onto the company involved.
The distinctive difference lies in who takes the liability of the sales ledger, and who claims responsibility of collecting payment. Correspondingly, there lies an essential variation in the confidentiality surrounding the instrument:
- The third party takes responsibility for the sales ledger, and will also carry out the chase of payments and credit control surrounding the transaction.
- The customer will settle their invoice with the third party factor. Consequently, customers are more likely to be aware of the factor arrangement in place, which may cause issues as the company is technically accepting a lower price.
- The original company that owns the accounts receivables will continue its obligations to chase payment and fulfil the upkeep of the sales ledger.
- The customer will still pay the company directly, and not the third party. Therefore, the customer has no way or right to know about any discounting arrangement applied to the transaction.
What are the advantages of bill discounting?
Invoice financing has many pros for small and medium businesses, the main being a material improvement in the businesses access to liquid cash.
- Improved cash flow and working capital
- Can be good for new startups
- The borrower only pays on the amount of money used, unlike a business loan
- Risk of bad debt or non-payment can be passed on to the financier
- Quick to access – funds can be released within 24 hour
At Trade Finance Global, our international team of bill discounting experts are here to help your business access working capital. Find out more about invoice finance and the different types in our guide here, or get in touch with our team and speak to one of our advisors.
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